Global investors seek more Canadian hedge funds

AmyOr

As Canadian hedge fund managers grab the attention of global investors, including their neighbors in the U.S., many are setting up offshore investment vehicles to capture the new money.

"In the past six months, there're close to a dozen Canadian funds launching offshore products. There were only two to three in each of the previous two years," said Sharon Grosman, president of SGGG Fund Services Inc., a Canadian fund administrator whose clients have $7 billion in alternative assets.

The offshore products allow non-Canadians to invest in Canadian funds without being subject to a 25% tax on dividends.

The heightened interest from foreign investors will likely give a much-needed boost to the budding $9 billion Canadian hedge fund industry.

And to global investors, Canadian funds, many of which invest in mining and resource businesses, represent a good way to tap the commodity rally driven by fast-growing emerging markets.

"Even though Canada is not an emerging market, it benefits ... from increased consumption in emerging economies," said Mark Purdy, managing director and chief investment officer of Toronto-based Arrow Capital Management Inc. Arrow is a investment manager with over $900 million in alternative assets.

The opportunity to diversify portfolios with Canadian funds comes at a time when some global investors are looking to pare down their heavy exposure to U.S. equities, which lately have been volatile.

However, Canadian funds' commodity focus can be a double-edged sword. The large amount of energy and resource-related stocks listed on the Toronto bourse also exposes Canadian funds to wild commodity swings.

According to Canadian Hedge Watch, Canadian funds dropped 2.41% in the commodity sell-off in May, steeper than the 1.18% fall among global peers as record by Hedge Fund Research. This came after a 13.41% rally last year, beating the global average of 10.4%.

Both SGGG's Grosman and Arrow Capital's Purdy believed short-term interest in Canadian funds may take a breather, but the long-term investment thesis is still intact.

"There will be a huge capital investment in the aftermath of the earthquake in Japan, and China may still stimulate growth after the current round of tightening in the banking system," Purdy said.

And if May's plunge teaches investors anything, it is the assurance that Canadian funds mostly don't have liquidity issues.

"Canadian hedge funds generally offer slightly better liquidity (than their U.S. counterparts), as they tend to invest in highly liquid products," said Ingrid Pierce, head of law firm Walkers's Cayman Hedge Fund Practice. She added that Canadian funds mostly don't have "side pockets." Many hedge funds set up side pockets or separate accounts during the height of the financial crisis to separate illiquid assets from more liquid ones.

The Canadian hedge fund industry has recently captivated the global investment community when manager Muddy Waters Research issued research papers accusing some listed Chinese companies of having committed accounting fraud. The ripples the firm caused were so far and wide that share prices at two companies the firm targeted over the past month -- Sino-Forest Corp. (TRE) and Spreadtrum Communications Inc. (SPRD), which denied the allegations -- plunged over 30% in a day, leading to handsome gains by Muddy Waters, which shorted the stocks.

But the high profile of Muddy Waters, founded by 34-year old Carson Block, is rather the exception than the rule.

"Ex-North American investors know New York when they think of hedge funds, but not necessarily Toronto," said James Burron, chief operating officer for trade group AIMA Canada. "Where is Toronto? they may even ask."

After all, Canadian hedge funds are at times too small for foreign investors, especially institutional ones, to feel they are worth going through the paperwork hassle entailed in hedge fund investing. The funds' average size, according to Canadian Hedge Watch, was a mere $60 million at the end of last year -- a drop in the bucket among multibillion U.S. outfits.

But despite the allure of global money, not all Canadian hedge fund managers are jumping at the chance to attract it.

A fund manager with $26 million said he has been asked a couple of times to set up an offshore vehicle, but decided to concentrate on domestic investors for the time being.

"It is on the want list, but not on the need list," he said. Domestic money alone, he said, will likely bring his fund size up to $50 million by the end of the year.

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